Like many traders, I read Market Wizards as a kid. If you don’t know it, it’s a collection of interviews with the most legendary traders of the 1980s.
Back when I first read it, I really had no idea what the hell I was doing. I read it, thought I got it and moved on.
But I didn’t get it.
The reason was simple. I didn’t have the life experience and wisdom to understand it. That would take many, many more years.
A few months ago I picked up my old, dog eared and highlighted copy and started thumbing through it. I expected to snag a few quotes and move on but pretty soon I found myself hooked, reading it cover to cover all over again.
Two things struck me immediately.
- First, I’d highlighted all the wrong things.
- Second, I saw instantly how much these men were alike.
No matter where they came from or how they got started, they all remembered one devastating loss early in their career. They all started with little to no idea what they were doing. All of them transcended false beliefs and developed an amazing ability to adapt and change their minds in a flash.
Their styles, politics and temperament all varied widely but the rest of their lives followed a remarkably similar path.
That’s when I realized I was seeing something bigger, a meta-pattern, a pattern of patterns.
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I am fascinated with history, or more specifically, market history and how investors reacted during different periods of different markets cycles.
Partly because I’m interested in history and partly because I want to be prepared for every market environment, I like to seek out investor letters and commentary from some of the best investors of all time during periods of market stress, such as the dot-com bubble or financial crisis.
Howard Marks (Trades, Portfolio) is undoubtedly one of the best commentators in this regard. His regular memos to investors have maintained the same investing framework ever since he started writing them in 1990. All that has changed during this period is the market environment. That’s very clear throughout the letters as Marks applies his cool, value-focused mind to every climate no matter what the prevailing consensus among Wall Street analysts.
The dot-com bust
I recently stumbled across one of Marks’ memos from 2000. Titled “We’re Not In 1999 Anymore, Toto,” the letter is a perfect example of Marks’ investing style. Just after the dot-com bubble had burst, the highly acclaimed billionaire uses the memo to provide a post-mortem on the market environment, and a look at what went wrong, as well as what went right.
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The S&P 500 hasn’t had a negative return for nine years now. There’s been some volatility in 2018 but overall things have been going pretty well for a while now.
When things are going well in the markets it can become easier for investors to focus on the minutiae.
Instead of focusing on the big picture — documenting your investment plan, asset allocation, diversification, financial planning, etc. — we start arguing about a few basis points in fees, the best formula for factor investment strategies, active vs. passive debates, and the like.
And don’t get me wrong — combining a handful of small edges in your portfolio can really add value when done in a thoughtful way.
But at a certain point, the law of diminishing returns kicks in and trying to optimise every minor detail can shift the focus from the things that truly matter in portfolio management.
Perfect is often the enemy of good when managing money.
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stockarchitect
March 11, 2019
Unusual challenges going forward in being a value investor, beyond active vs. passive or quant-based.
How the view of value investing has evolved over time.
One fact you should never forget: Investing is if you are judged relative to the market a zero-sum game. Asset by class by asset class, the average return to all investors in that asset class has to be the average return to all assets in that asset class. All the assets are owned by somebody, and the derivatives net out. If the asset class if up by 12%, the average investor is going to be up by 12%. What that means: If you’re going to be above average, somebody else has to be below average. That’s important because it seems good that more people are doing passive, leaving less competition. But it’s not true because you need someone to be stupid.
First reality: To the extent that the people who are doing index funds are people who populated the lower half of the investment distribution, it’s going to make your life harder not easier.
Second reality: Late cycle underperformance of value. Not something that should upset you. Today, we are in the middle of a fundamental change in the nature of profitability and in the nature of value generation that is related to a fundamental underlying change in society ad I think in various ways it has made value investing substantially harder.
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Michael Batnick’s new book, Big Mistakes: The Best Investors and Their Worst Investments came out this week.
There are far too many investing books that dissect the past successes of history’s greatest investors. These books make it easy for investors to assume emulating these greats should be effortless. I know that’s what I thought when I read about Buffett and Graham when I first started investing.
Most investors would be far better off trying to avoid mistakes than replicate their favorite billionaire’s track record. This book chronicles every mistake imaginable in the markets and it does so in a refreshing way by showing even the most intelligent among us screw up.
Here are six things I learned from the book:
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Daniel Kahneman once said, “Hindsight makes surprises vanish.” The hindsight bias can lead investors to constantly fight the last war. Since the financial crisis the last war has made top calling in the markets a cottage industry. Looking back now the peak before the prior crash looks easy. It was not. Predicting when the music will stop is not easy. This piece I wrote for Bloomberg shows why.
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There’s a simple reason the future always feels uncertain but the past seems relatively orderly: No one has any idea what the future holds, while hindsight allows us to assume that the past was more predictable that it actually was.
Take the Great Financial Crisis. The majority of investors, economists, policy makers and regulators were completely blindsided by the worst economic and stock-market downturn since the Great Depression. Yet when these same people look back at that fateful 2007-2009 period, it seems many of them now believe that they knew it was coming and called it in advance.
It can be very lucrative to be right about major market events. Many who actually did see the crisis coming became household names in the finance industry and parlayed that success into book deals, keynote speeches, television appearances and “thought leader” status. Since so many people were cheerleading right up until the market crash, no one wants to get caught flat-footed again, leading to a steady increase in the number of people now calling for a market top.
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Steve Wendel, head of behavioural sciences at Morningstar, chatted with markets editor Jeremy Glaser to come up with some ideas on how to keep your cool when the market isn’t. The entire interaction
can be seen here. Below are the takeaways.
Understand that volatility, downward or upward, is just data.
Avoid looking at your portfolio on a daily basis, specially when there is tremendous volatility. There’s lots of research on how frequently checking your portfolio, especially during market downturns, can warp one’s behaviour and get you into trouble.
Remember that our minds play tricks on us.
If the market drops, that’s past. That’s gone. There’s nothing we can do about it. It’s really as we think forward to what will happen that our minds take that data and apply a story.
If you don’t know what that story is, it’s probably the bias of recency bias–thinking that what just happened is about to happen. But when we think about that rationally, we of course know that’s not the case.
One of the things that we can do is to round out that story: This just happened; this is what I believe is about to happen; what’s the rightful thing to do? For most professional, thoughtful investors, they know it means you look for bargains. Same exact data. Very different outcome.
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Only price pays. In trading, emotions and egos are expensive collaborators. Our goal as traders is to capture price moves inside our time frame, while limiting our drawdowns in capital.
The longer I have traded, the more I have become an advocate of price action. Moving away from the perils of opinions and predictions has improved my mental well-being, and my bottom line. It also makes it easier to create and adapt to trading rules.
“WE LEARNED JUST TO GO WITH THE CHART. WHY WORK WHEN MR. MARKET CAN DO IT FOR YOU?” – PAUL TUDOR JONES
In developing a trading system of your own, you must begin with the big picture. First, look at the price action and then work your way down into your own time frame. You need to create a systematic and specific approach to entering and exiting trades, executing your signals with the right trailing stops, setting realistic price targets and position sizing, and limiting your risk exposure. Relying on fact, rather than being tossed around by your own subjective feelings, will insure your long term profitability.
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“If you wake up thinking about a position, it’s too big” Steve Clarke
“Make your position size more a function of not how much you can make, but really how much you can lose. So manage your position based on your downward loss perspective not your upward potential.” James Dinan
“We will make something a large position if we think there is an extremely low chance of losing money on a permanent basis. Even if we think it might be a 4X return, if the idea could be a zero, it’ll be a small position” Ken Shubin Stein
“I’ll limit position sizes when potential outcomes are too binary” Chris Mittleman
“We do not bet the ranch on any single investment; few positions have exceeded 5% of assets in recent years” Seth Klarman
“We size things based on how much we think we can make versus how much we think we can lose. We’ll probably be willing to lose 5-6% of our capital in any one investment” Bill Ackman
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Before we begin our discussion about how to trade Elliott Wave let’s set the stage by looking at how the Elliott Wave theory was discovered and why Elliott wave strategy is so popular today. In the 1930 R.N. Elliott set out to try to learn more about the stock market after experiencing some losses in the 1929 stock market crash.
Elliott’s discoveries were quite impressive and after careful study of the markets, he began to notice that the market has some repeatable patterns and is trading in a series of five and three waves which is what we call today an Elliott wave strategy.
Our team at Trading Strategy Guides has also adopted the Elliott Wave strategy because it offers us good Elliott Wave entry points which ultimately leads to superior risk to reward ratio.
The Elliott wave strategy is similar to a trend following strategy like the MACD Trend Following Strategy- Simple to learn Trading Strategy or the very popular strategy: How to Profit from Trading Pullbacks.
Even though the Elliott Wave strategy is a trend following strategy, we can spot Elliott Wave entry points even on the lower time frames because the Elliott Wave theory can be applied to all time frames and to all markets so, in essence, is a universal trading strategy.
Now …
Let’s get a little bit deeper into how to trade Elliott Wave and how we can make profits trading.
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